A dividend reinvestment plan (DRIP) is an offer by a company or brokerage account that allows you to automatically buy additional shares with your dividend payments. Rather than cash deposited in your account on the payment date, you will receive new shares in the stock.
DRIPs and advantages
There are really two advantages of DRIPs. First, there are usually little or no fees in reinvesting your dividends. Depending on how much you normally pay to buy shares, this could be a big discount over time. Some companies even offer a discount on the share price for reinvested dividends. Most programs allow you to buy fractional shares as well so you do not have to wait for your dividends to be reinvested in a whole share.
The biggest advantage of DRIPs is the effect of compounding returns over time. Each share or fractional share that you buy with your dividends is a larger ownership in the company and means more dividends in the future.
Remember that 100 shares of Coca-Cola Company? Reinvesting the $30 quarterly dividend may not seem like it could amount to much but over decades it could mean a portfolio several times larger. If you had invested $10,000 in Coca-Cola shares in 1964, the difference between reinvesting or not is more than one million dollars!
Don’t think you have to hold shares for decades to see the benefits of a DRIP. An investment in shares of Johnson & Johnson (JNJ) over the two years to April 2014 with dividends reinvested would mean a return 3% higher than if dividends were just held in cash and an extra $230 in your account.
Potential disadvantages of DRIPs
Dividend reinvestment is not without its disadvantages. You are essentially putting more of your eggs in one basket with a constant reinvestment into the same company. This could set you up for an unbalanced portfolio and big losses on if that company ever falls on hard times. Reinvestment also means that you will not be able to use that cash for current spending needs or really to decide what you want to do with it.
Reinvestment plans can be stopped at any time so the disadvantages may not be as permanent as they appear. Many plans even allow you to only reinvest a portion of the dividends instead of the full amount.
Setting up your dividend reinvestment plan
Whether you have all of your investments in one particular brokerage account or with individual companies, setting up a dividend reinvestment plans is usually straight forward and simple. For your investments held in a brokerage account, call the customer service line and ask which shares offer DRIPs or if you can enroll your entire account at once. Even if a particular company does not offer a DRIP, your brokerage may offer the service.
You can also go directly to the company to see if they offer a DRIP for shares. Contact the company’s Investor Relations or Shareholder Services department. They will be able to tell you how to enroll for the program as well as any fees or discounts.